Crisis Canice Liu Daniel Lim Eric Pradas Irmo Holslag Jordan Banov

Agenda Exchange Rate Regime Banking System Foreign/Domestic Debt Inflation BOP Summarize Compare other crisis Conclude

Exchange Rate Regime Managed float up to 1999 Pre-announced crawling peg starting 2000 – Stabilization program supported by IMF – Exit strategy after 18 months

The Banking System Corruption – Banking licenses – Established and creditworthy borrowers Uncovered Interest Arbitrage – Borrowed at cheaper foreign interest rates to invest in high yield domestic bonds

FX/Lira Deposits /I2000/II2000/III2000/IV2001/I2001/II Private Banks State Banks

Total Foreign Debt

Total Domestic Debt (Treasury) To finance budget deficit Impact on inflation

Inflation & The Lira High inflation vs. insufficient devaluation of the lira Government spending (budget deficit) Introduce crawling peg – inflation slow down

Balance of Payments Imports > Exports because of overvalued lira – Negative trade balance – 22.4 billion – CA deficit: 1.3 billion (1999) to 9.8 billion (2000) Financial account surplus – Seemed to indicate growing confidence – Warning sign – 7 billion increase in “net other investments”

Foreign exchange reserves of the Central Bank (Million dollars, Weekly Data, )

Over-night Rate

Adding it up The banking system High levels of debt Exchange rate misalignment Current account deficit Insufficient actions on behalf of the government => Led to loss of investor confidence, speculation, massive capital flight, floating lira

Russian Crisis of 1998 Comparison with Turkey’s crisis: – Corrupt practices and weak financial institutions – High levels of bad debt – External shocks – However in Russia, fundamental reason was not BOP deficit, but bad government.

Brazilian Crisis of 1999 Similarities: Governments pursued a gradual but continual devaluation policy High inflation rates (but lowered for Turkey in 2000) Governments couldn’t keep the value of the currency after investors pulled their money out of the country Both countries ended up with a floating exchange rate

Asian Crisis Similarities: Corruption Exchange rate misalignment Persistent Current account deficit Weak financial institutions – Uncovered Interest Arbitrage – High debt level Speculative pressure – Crisis of confidence

Conclusion Turkey’s Kriz reflected the underlying economic instability Crises can be prevented by close monitoring of financial indicators Recipe for crisis: – 2 cups inflation – Bowl of corruption – Sprinkle of economic boom – Exchange rate fluctuation mixed with lots of debt – Cook it on a “slow” government