Turkey Financial Liberation

8/8/2019 Turkey Financial Liberation

http://slidepdf.com/reader/full/turkey-financial-liberation 1/3

Financial Liberalisation in Turkey

Background to the economy and reforms

From the 1960s until 1980 Turkey had anuncompetitive financial market and an inefficientbanking system characterized by controlledinterest rates, directed credit, high reserverequirements, restricted entry of new banks andother restrictions on financial intermediation.Many banks also exited Turkey during this periodtherefore creating a concentrated marketdominated by banks owned by industrial groupswith oversized branch networks and highoverhead costs. The sector served was structuredto support state-oriented development and servedas an instrument of planned industrialisation

In the 1970s Turkey, as other developingcountries, experienced weaknesses in its importsubstitution strategy and attempted to overcomethese by gearing towards a more outwardoriented economic development strategy.Attempts at trade liberalisation were made in the1970s but these were generally unsuccessful asthey were only short-term solutions to balance-of-payments and foreign exchange problems.

During the 1980’s there was an acceleratedreform and adjustment process in almost allsectors of the economy which started withliberalisation of the foreign trade regime and thefinancial sector, and culminated in theliberalisation of capital accounts in late 1989. Aflexible exchange rate policy was also introducedas were more effective measures to promoteexport growth and gradually liberalise imports tomake Turkey more open to foreign trade. Thismove towards greater freedom of trade createdthe necessary external environment to enableTurkey to benefit from trade gains.

Reforms also eliminated interest rate controls,made it easier for new financial institutions toenter the market, and introduced new types of financial instruments. Regulatory barriers wererelaxed therefore attracting many banks, bothTurkish and foreign, into the system andintegrating it with world markets. The overall aimof the reforms was to change the nature of theeconomy from statism to a market structure withthe objective of achieving a more efficientallocation of resources through the pricemechanism. Another aspect of Turkish financialliberalisation was that it was undertaken with aview to gaining eventual membership of the EU.

During the 1990s Turkey’s economy wascharacterised by high inflation, high publicborrowing and high interest rates which crowdedout private sector direct investments. There wasalso a lack of fiscal discipline, transparency and

accountability in the public sector and major structural problems in others sectors includingbanking, energy, telecommunications and publicprocurement. The country experienced severerecessions in 1994 and 1999 after theearthquake, and a serious banking crisis in 2001.Government efforts at economic reform were half-hearted with frequent reversals and hesitantforward movements caused partly by politicaluncertainty and partly by a reluctance to acceptthe changing global economic realities. However,after coming to power in June 1999, Ecevit'scoalition government accelerated the economicreform process by passing a series of laws onbanking regulations, reform of the loss-makingpensions system, and international arbitration ininvestment disputes. In August of that year parliament also approved constitutional changesclearing the way for private power projects andprivatisations of key energy companies includingPetrol Ofisi and Tupras which were privatised inearly in 2000.

In April 2000, a decree to break up the statepower company Teas into three companies for generation, transmission and sales cleared theway for the World Bank's $750m loan, and afurther decree subsidised farmers directly insteadof propping up agricultural prices. From thebeginning of 2000, the Central Bank pegged thelira at a new exchange rate against both the USdollar and the euro and in February 2001 movedto a floating exchange rate. The Central Bank alsobecame independent in May that year. A further spate of reforms was enacted between 2002 and2007 around three key areas:

1. Structural reforms: speeding up of privatizationof the public sector, financial sector andenhancement of the role of the private sector toattract larger foreign direct investment (FDI)inflows.

2. Fiscal policy: primary budget surplus, debtmanagement, social security and tax reforms.

3. Monetary policy: independence of CentralBank, inflation targeting (January 2006), andmaintenance of the floating exchanger rateregime.

Turkey’ s aim was to continue with acomprehensive economic reform programme witha view to avoiding falling back into the boom-bustcycle of the past and overcoming the dualitiesbetween the few highly productive enterprises andthe large number of low productivity companiesthat hindered the country's long-term growthperformance. It is also took steps to movetowards a competitive market economy through a

1



continuation of structural reforms includingcompletion of the privatisation agenda and other sectoral reforms including labour, education andhealth.

Effects of the reforms

Turkey's reform programme has resulted inimpressive economic performance in the past fewyears. GNP growth averaged 7.4% per year during 2002 - 2006 compared with -1.6% between1998 and 2001. GDP growth in 2007 was 4.5%and cumulative growth between 2002 and 2007was 40%. This was led largely by privateinvestment and consumption and also fuelled bylarge capital inflows, declining interest rates andcredit expansion. Total factor productivity growthalso played an important role, having increasedfrom an annual average of 24.5% during 1996 -2000 to 42% between 2001 and 2005. Due to therobust economic growth, the unemployment ratedecreased from 10.3% in 2002 to 9.9% in 2006.From a high of over 80% in the 1990s, inflationhas reduced to single digits since 2004. Publicsector debt decreased from 91% of GNP in 2001to 29.2% in 2007. By the end of 2007 internationalreserves exceeded US$ 76.4bn, more than 11.6%of GDP. Privatisation revenue amounted to US$8bn in 2006 and US$ 4bn in 2007. Financialmarkets have performed well and banks haveimproved both their capital adequacy, to over 30%, and also their profitability. The primarygeneral government budget operated an averagesurplus of 5 percent of GDP from 2004 to 2008.

Turkey's merchandise exports have more thandoubled since 2002 and reached US$ 107bn in2007. Manufactured goods contributed over 80%of this followed by agriculture and miningproducts. Machinery and transport equipment,automotive products, textiles, food, iron and steel,and chemicals are the main exports. In particular,the share of automotive goods in totalmerchandise exports has risen substantially over the last few years, while that of textile and clothingproducts has declined. More than half of Turkey'sexports still go to the EC and Germany remainsthe single major export market followed by theUnited Kingdom, France, Italy and the USA. Thereason for the change in the commodity

composition of Turkish exports was the newdevelopment strategy which targetedindustrialisation through export growth andresources were thus reallocated from theagricultural sector to industry. Turkey wasexporting mainly resource-intensive agriculturalproducts in the 1970s, labour-intensive textiles,together with leather and hide in the 1980s, whilerapidly growing capital-intensive export industriesemerged in the 1990s. Turkey continues to buildon an extensive network of preferential tradeagreements due to its customs union with the EC.

Merchandise imports have also more thandoubled since 2002 and reached US$ 170bn in2007. Manufactured goods represented about twothirds of total merchandise imports followed bymining and agriculture products. Machinery andtransport equipment, chemicals and automotiveproducts constitute the main imports. About half of Turkey's goods imports originate in Europe,mostly in the EU and Germany is still the leading

source of Turkey's imports, followed by theRussian Federation, China, and the USA. Turkeycontinues to be a net exporter of services andgenerated a surplus of almost US$ 14bn in 2007.The extent of openness of the Turkish economycan be calculated by the ratio of exports andimports to GDP and this was 17% in 1970, risingto 20% in 1980 and to 34% in 1995. Reduction or elimination of tariffs and quotas, and themovement of resources from import-substitutingactivity to the growth of export industries were themain contributing factors in the liberalisation of imports.

FDI inflows rose from an average of US$ 791million during 1990 - 2000 to US$ 3,852 millionbetween 2002 and 2005. This rose further fromUS$ 10bn in 2005 to US$ 22bn in 2007. Theservices sector has attracted the large majority of FDI inflows partly due to the privatisations of several state-owned companies, followed bymanufacturing. However, FDI in agriculture andmining has been very low. The EU is the largestsource of foreign direct investment in Turkeyproviding almost 86% of its resources in 1996and, although this has declined since, it stillprovides more than half of FDI. Nevertheless, anumber of sectors are still subject to FDI

restrictions including broadcasting, fishing,petroleum, mining and financial services.

Although reform has reduced concentration in thebanking sector, some problems remain. Leadingbanks are still able to coordinate their pricingdecisions, therefore high profitability has resultedfrom uncompetitive pricing rather than efficiency.Deregulation and liberalisation need to becontinued and strengthened as market entry of small-scale banks alone is not enough to increasecompetition as these are incapable of alteringmarket structure. Further reform requiresaddressing barriers to entry and reducing thepower of the large banks which exert a significantnegative effect on competition. Also, interbankrivalry among the leading banks cannot befacilitated without creating new banks of a certainsize with a reasonable number of branches.Breaking up public banks, which hold 30 percentof the sector’s assets, excluding the AgriculturalBank and three development banks, could helpcreate 15 to 20 new banks with 40 to 50branches. This would reduce concentration andimprove mobility in retail banking. Breaking uppublic banks before privatisation may also

2



improve their governance structures andefficiency. Promoting the entry of non- banks andlocal banks would also increase the number of institutions competing for deposits. Turkey lacks ahealthy variety of credit institutions and shouldconsider developing a mortgage market andinstitutions for housing finance.

Turkey’s economy has shown more resilience

than many in the recent financial crisis.International rating agencies have recentlyupgraded the country’s ratings to BB, the fourthupgrading in three months, therefore recognisingthe progress made in macroeconomicmanagement of the economy. Inflation hasdecreased and growth expectations for 2010 areon the rise. However, unemployment at 13.1%, upfrom 11.0% a year earlier, is still a concern.

The Future

Under Turkey's ninth development plan, GDP is

expected to increase at an annual average rate of 7% between 2007 and 2013, with a projected per capita income of US$10,100 by 2013. The shareof agriculture to GDP is to decline to 7.8% by2013, while the contributions of manufacturingand services are projected to increase to 27.2%and 65% respectively. Exports of goods andservices, as a percentage of GDP are to rise from28.2% in 2006 to 32.4% in 2013, while importsare to fall from 35.9% to 35.8%. Turkey's long-term strategy up to 2023 envisages promoting anexport-oriented, technology-intensive productionstructure with emphasis on high-value-addedmanufactured products and services. This is to be

achieved at the expense of agriculture, which isprojected to fall to 5% of GNP by 2023. In the longterm, the ratio of total investment expenditures toGNP is expected to increase from c. 22% in 2000to approximately 27% in 2023, and the share of the public sector in total investments to decreasefrom 30% to 10%.

Unlike the other Muslim countries in the MiddleEast, Turkey is the only one that is progressingsimultaneously on both the political and economicfronts in terms of liberalisation. Democracy isestablishing itself, although Turkish liberalism is atpresent limited mainly to secular lifestyles and still

has to make progress with regard to civil and legalrights. In this respect, efforts are underway to alter some structures to bring them more in line withthose of EU member states. Economicliberalisation is a complex issue from the Turkishperspective because, unlike most other Muslimcountries of the Middle East, leaders must takedecisions with one eye on what voters think. Thiscan have a slowing effect on the pace of reform inthe short-term but the changes that are beingimplemented are being brought about by a broad

consensus and therefore are not likely to bereversed.

The moves towards liberalisation in the politicaland economic spheres are being undertaken bythe secular Turkish leadership - both military andcivilian - with a good understanding of the globalsituation. They are well aware that the world ismoving towards a multi-polar environment and the

objective is to make Turkey one of the importantpoles with links to Europe, the Middle East andCentral Asia.

The energy sector is seen as a strategic catalystwhich can help make this happen. Turkeycontinues to project itself as a corridor for energysupplies to Europe from Central Asia and theMiddle East, although none of the big pipelineprojects has materialised so far. Negotiations for membership to the EU continue to be slow but if adeal can be reached over the dispute regardingCyprus, then things could move forward.

Finally, a debate exists as to the causes of financial liberalisation in Turkey i.e. are financialreforms the result of economic growth, or havethe reforms led that growth. There is probably anelement of both but, on balance, the reformswould appear to have been driven more byTurkey’s economic growth and further reforms arelikely as the country becomes increasinglyexposed to world markets and the effects of globalization.

February 2010

3

Documents

Turkey Financial Liberation