Strong Turkish Currency Raises Fears of Economic Setbacks

Turkey, now more than a year removed from its February 2001 financial crisis, is officially in economic recovery. The International Monetary Fund approved a fresh round of financing in February, and politicians have taken pains to stress just how well everything has been going. Yet recent statements from senior IMF, World Bank and Turkish business figures have splashed cold water on the prospects of a warmer economy.

The Turkish lira trades at high exchange rates to major world currencies, but Turkey's economy has not grown appreciably, and its Finance Ministry is carrying out a major banking reform that may sap consumer confidence. Jitters have surfaced in Ankara because an overvalued currency and a banking sector problem foreshadowed the 2001 crisis.

Confusingly, it's Turkey's strong currency that worries financial experts. Last year, a crisis in Turkey's banks led to a rapid and largely uncontrolled devaluation in the Turkish lira. [For more information see the EurasiaNet Business and Economics archive]. Before the crisis, a US dollar traded for around 650,000 lira. By the end of the summer, the same amount of lira was worth less than thirty cents. Over the last few months, though, the lira has gained value, appreciating by some 20 percent.

A more valuable – "stronger," in economic parlance – lira will make Turkish exports more expensive, which is one worry. The other concern is that Turkey's banks, which have long struggled to keep cash plentiful, are trying to make money off the strong lira by borrowing foreign currency to buy Turkish-denominated bonds. Inside the country, inflation is running around 65 percent, so banks can achieve fast and dramatic gains by borrowing foreign currency, buying bonds, and paying back the loan with highly valued Turkish lira. But this only works as long as the lira keeps growing more expensive on world currency markets. If currency traders start to discount the Turkish lira, the banks could end up owing money they can't repay. And the possibility of default could cause another bank run.

While currency trading can keep banks liquid and promote wealth, it does not necessarily stimulate investment in infrastructure and jobs. For that reason, some observers want to see Turkey's fiscal and monetary policies focus on economic growth. "I think the biggest focus must be on growth," Ajay Chibber, the World Bank's representative in Turkey said in late April. "This will require focusing also on the exchange rate because the competitiveness of the real exchange rate is an issue now."

Looming foreign exchange debts also dominated the remarks of billionaire industrialist Sakip Sabanci – one of Turkey's most powerful business leaders. In a late April speech at the World Turkish Businessmen's Convention in Istanbul, Sabanci lambasted the government over the scope of its debts to the IMF and other international lenders. Since the crisis, Turkey has become the biggest IMF debtor, tacking on another billion dollars to its $31 billion obligation in April. "We spent US $200 billion," said Sabanci, referring to Turkey's total debts, which reached $90 billion of domestic debt at the end of March. "We couldn't reduce inflation," Sabanci continued. "Did we manage to complete privatization? Is the stock exchange any good? No."

More public comments like Sabanci's could certainly hurt the lira. While the government condemned Sabanci's remarks, the business community praised him for making them – particularly his reference to privatization. Since the 1980s, Turkey has been privatizing its huge state industries, but the process has gone slowly. [For more information, see the EurasiaNet Business and Economics archive]. Ugur Bayar lost his job as head of the privatization authority on April 10, allegedly after fighting with government ministers over the sharing of information. Without Bayar, whom international news organizations portrayed as a well-respected professional, worries about the pace and depth of privatization figure to spread.

Privatization and financial retooling bring political pain that could in turn bear on the exchange rate. The IMF recently called on Turkey to trim around 100,000 jobs in state industries and departments, a move likely to meet heavy resistance. At the same time, the IMF's proposed major reform in the banking system is already underway. Under the reform, Turkey's banks must hold a certain minimum level of liquidity in order to retain their operating licenses. If they do not have this level, the government will use IMF and World Bank money to help them reach it. Officials hope this technique will strengthen the banking system and bring back confidence, which has suffered amid the collapse of a number of banks.

But to become eligible for an infusion, institutions have to open their accounts to government inspectors. This is a routine process in many countries, but Turkey has never attempted it in this detail. What inspectors find – in matters having to do with foreign exchange and other activities – will determine how much cash international lenders need to provide. This amount is subject to great conjecture. If banks have a lot of money riding on the strong lira, inspectors might criticize them and issue reports that would hit consumer confidence and could effect the exchange rate. Inspectors' reports are due any time over the next two months. There are plenty of Turks, and foreign investors, quietly holding their breath.