Global Policy Forum

Susanna Mitchell

Synopsis

Turkey faces a critical and bitterly contested election at the beginning of November, and its economy is once again hovering on the point of insolvency. This paper explains the connection between the country's past and present economic crises, and seeks to identify the cause of the problem. It also briefly outlines at the political situation within the country, and examines its strategic importance to the West.

Turkey and the November elections

Turkey will go to the polls on November 3rd, and its election campaign is focused on three issues of central importance: its economy, its application for EU membership, and the US/Iraqi situation. These are all areas where Western interests are heavily involved, and Turkey's increasing indebtedness and her heavy dependence on international loans gives the Western institutions considerable leverage in the political arena. Despite the government's repeated failures to stabilise the economy and its lamentable human rights record, a continuing flow of IMF rescue packages has served to consolidate this situation, and the country is now one of the Fund's largest borrowers. The election of a pro-Western government, committed to extensive economic liberalisation under the aegis of the IMF would clearly be of advantage both to Europe and the United States.

Turkey's politics are extremely complex and turbulent [1], but since 1999 the country has enjoyed some stability under a coalition government consisting of the centre-left Democratic Left Party (DSP) led by the Prime Minister, the veteran politician Bulent Ecevit, and two rightwing parties, the far-right Nationalist Action Party (MHP) and the centre-right Motherland Party (ANAP). However, although West and the IFIs clearly preferred Bulent Ecevit's coalition to the prospect of political chaos in Turkey, the alliance has long been recognised as an awkward one, and has never been wholly malleable. For instance, the biggest party in the coalition, the MHP, strongly opposes the package of human rights reforms demanded as a prerequisite for starting Turkey's entry talks for the EU.

At the other end of the spectrum, Bulent Ecevit's DSP was traditionally opposed to market reforms, and although it has become much more moderate in the last five years, the repeated failure of its new economic policies has now lost it the support it once enjoyed. In addition, the Prime Minister himself is a fierce nationalist and is – or was – also a committed social democrat. Although he has been in poor health for some time, he repeatedly refused to comply with calls for his resignation, but in July this year, a stream of defections from his cabinet brought the coalition to the point of collapse, and certain factions, including the MHP, demanded early elections. At the end of the month and in the teeth of Ecevit's opposition, the Turkish Parliament agreed to this request, and the election date was set nearly 18 months ahead of schedule.

For many reasons this is an extremely contentious decision, and the country has been plunged into a state of political turmoil. However, although the election campaign is proving as ruthless as expected and its outcome remains in considerable doubt, there is strong possibility that a new government will prove to be more reliably in tune with Western objectives.

For some time it seemed probable that the New Turkey Party (YTP), recently launched by Ecevit's ex-foreign minister, Ismail Cem, would be the leading contender among the many centrist parties. Cem's prospects, however, largely depended upon the support of Kemal Dervis, a former World Bank vice-president, who was recruited as Finance Minister by the Turkish government in March 2001 following the devastating currency crisis of February and the abandonment of the peg. [2] Although nationalist elements in the government accuse Dervis of taking orders from the IMF and the United States, and the painful social effects of IMF-led economic reforms threaten to make him unpopular among the poor and the unemployed, he enjoys the support of leading business men and industrialists, and his standing with the IFIs makes his backing of enormous importance to any political party.

Dervis stayed on the fence for some time as he assessed his prospects. At first he refused to leave Ecevit's government, claiming that the country's current economic problems made it necessary for him to remain in office, but he finally resigned in August, somewhat ambiguously declaring that he was `working politically' with Cem. Cem's YTP were delighted, but their hopes were subsequently shattered when he announced that he was instead joining the DSP's old rivals, Deniz Baykal's Republican Peoples' Party (CHP). It is now assumed that he will lead several centrist parties from this base, attempting to unite them as an electioneering force.

At the same time, opinion polls have shown that the Islamic Justice and Development Party (AKP), is likely to win between 20% and 25% of the vote, making it the largest group in parliament. This is a grave disappointment to those who hoped that the party's chances would be ruined because its leader, Recep Tayyip Erdogan, has been banned from active politics until next January and cannot take part in an early election. The far right and the army have expressed fury at the prospect of an AKP government, while Bulent Ecevit has warned that such an outcome, plus a possible Kurdish presence should HADEP cross the 10% threshold, would threaten the secular and unitary nature of the Turkish State and adversely affect its relations with the US. This is, of course, a conceivable scenario, and should it develop the possibility of another military coup cannot be disregarded.

Erdogan, however, now claims that his party is `for democracy, secularism, justice and social welfare', and moreover is actively pro-Europe. While sceptics doubt the sincerity of this stance, it should be noted that the AKP has in fact come out in support of the EU reform package, and has always voted to renew the six-month US lease agreement for use of the airbase at Incirlik If – as currently seems more probable – the elections result in a coalition of centrists led by Dervis and the CHP, and a westward-looking Islamic party such as Erdogan's, neo-liberal economic reforms will be even more enthusiastically implemented than they have been under the present government.

In that case, debt-creating loans will continue to mount, and to erode Turkey's political autonomy. Whatever the new Turkish government's religious and cultural preferences, and despite well-founded fears regarding escalating conflict in the Middle East, this economic dependence will leave the country increasingly unable to resist the dangerous and unwelcome co-operation demanded by the United States in its so-called war against terrorism.

General Background – Turkey and the West

Turkey lies between the Middle East and Europe, and its landmass separates the Black Sea from the Mediterranean. It is the only Muslim country in NATO, and is now hoping to join the EU, although it is still some way from fulfilling the requirements of membership, despite the recent amendments to its human rights legislation. During the cold war it was a valuable ally of the United States, and both its geographical position and its status as a secular Muslim state continue to make it of great strategic importance to the West.

In the Gulf War the country emerged as a strong supporter of the US/British alliance, and British planes still rely on a Turkish base as a launching pad for incursions into the no-fly zone in Iraq. US military flights were also allowed to use Turkey's airspace and its Air Force base at Incirlik when waging war against Afghanistan.

The country's relationship with its neighbours, however, remains somewhat ambiguous. Although it shares borders with Syria, Iraq and Iran, it is now the only country in the region to maintain friendly relations with Israel. At the same time, its own pro-Islamic opposition parties continually condemn Israeli action against the Palestinians, and mainstream politicians have also expressed dismay regarding many of Sharon's current policies.

If the United States goes ahead with its avowed intention of waging war on Iraq, Turkey's support will be critical, but so far the Turkish government has explicitly opposed any suggestion of US-led military intervention. Instead, the Turkish Prime Minister has declared that his country wishes to preserve good relations with Iraq, and that it is possible to ameliorate the `so-called Iraqi problem' without resorting to war. Indeed, despite its strong military presence, and a highly aggressive attitude towards territorial disputes with Greece and its own Kurdish minority, Bulent Ecevit continues to describe Turkey as `a force for peace' in the area. He indicated, nonetheless, that if a US strike were to be approved by the UN, Turkey's views might change.

Turkish attitudes towards Saddam Hussein's regime in Iraq are deeply influenced by its intransigent approach towards the claims of its own Kurdish people. This large minority of some 12 million comprises roughly one fifth of Turkey's population, and Turkey has long denied their desire for a separate Kurdish state. Iraq has a smaller Kurdish population (some 3.6 million), but although they are beleaguered, they have set up a surprisingly successful autonomous community in northern Iraq, and it is clear that they feel that the end of Saddam Hussein's regime would enable them to achieve full independence, probably supported by the US. This idea horrifies the Turks, who consider that the creation of a separate Kurdish State in Iraq would be the precursor of a similar split in Turkey, possibly leading to a united Kurdish nation. Over the past decade the Turkish forces have made frequent incursions into the Kurdish enclave in Iraq, ostensibly pursuing PKK fugitives, and Turkey has warned that any hint of independence there would be met with a military response.

To date, Turkey's Kurds have also been refused any form of cultural autonomy, including the right to be educated and to publish and broadcast in Kurdish, and Turkey has continued to harasses, and sometimes to ban the political organisations that have replaced the militant Kurdistan Workers' Party (PKK) which has been officially disbanded. However, the whole question of Kurdish rights formed part of a reform package of requirements for joining the EU, and although it remained highly contentious, this package was hastily passed by the Turkish parliament in August 2002, in order that the Turkish application for membership could go forward for consideration at the EU meeting in December. Obviously, these measures to improve the lot of the Kurds have yet to be implemented.

Current economic situation

Since 1980, Turkey has been following a programme of economic liberalisation promoted by the multilateral institutions, and designed to protect the assets of foreign creditors. During this period she has experienced a series of severe financial crises, and her economy has been characterised by wildly fluctuating capital flows, stubbornly persistent inflation and steadily mounting domestic and external debt. The country is now one of the IMF's largest borrowers, and has received four major bailouts by the Fund in the last two and a half years alone (December 1999, December 2000, May 2001 and February 2002).

The most recent of these bailouts (February 2002) took the form of an additional rescue-package of $12bn, bringing Turkey's total indebtedness to the Fund to $16.3bn. This new loan was advanced in response to a particularly severe crisis in 2001, which saw the economy plunged into its deepest recession since the 1940s. During the year, real GNP fell by 9.4%, export growth slowed, and unemployment increased. Inflation soared to an average of 78.5% (up from 35.8%) for the 12-month period, and massive capital flight (estimated at some $17bn) depleted the country's reserves. Meanwhile, net external debt increased to 36.8% of GNP (up from 18.3% in 2000), and net domestic debt rose to 56.5% of GNP (up from 39.1% in 2000). This left net public sector debt for 2001 standing at 93.3% of GNP (up from 57.4% of GNP in 2000). [3]

The IMF's latest $12bn rescue package is to be to be disbursed in several tranches over the next three years. A new `intensified' Fund-supported economic programme has been initiated, with disbursement conditional on bimonthly IMF reviews of progress. Much of this latest bailout is designed to enable Turkey to repay existing debts ($6bn of the first year's disbursement of $9bn, for instance, is designed to service previous loans).

At present, industrial production remains stagnant, unemployment has risen, export growth has slowed, and financial markets remain fragile. The recent collapse of the ruling coalition, led by the Democratic Left party under Bluent Ecevit, has given rise to acute political instability, further discouraging investor confidence. Although the IMF have so far refused to abandon their 3% growth projection or their target of 35% inflation for 2002, even they admit to `concern about the uncertain prospects for near-term recovery' of which there is as yet no sign. Should this recovery fail to transpire, there is no prospect of reducing the country's unsustainable public debt burden of 93.3% of GNP to the 60% projected by the IMF by 2006.

In short, a well-known scenario is being replayed yet again. Years of IMF advice and increasing debt obligation have left a strong and vibrant country, self-sufficient in food and industrially capable, at the point of economic collapse, with its government hovering on the edge of a default on its public debt. In the case of Turkey, however, the IMF's new policy – that of abruptly removing support from economies where its programmes have failed to deliver – has not been in evidence. Unlike Argentina (also a recipient of decades of IMF policy dictates), Turkey has continued to receive IMF bailouts in the face of clear insolvency.

We make two suggestions below; firstly, that the IMF programmes that have led Turkey to its present situation contain the same fundamental flaws that have caused crises in other emerging market economies; and secondly that its present support is influenced by Turkey's critical geographical and strategic significance in the US `war on terrorism', in particular with regard to a possible American offensive against Iraq.

Economic background [4]

The first IFI-backed stabilisation/liberalisation programme, instituted under the military regime of 1980-1983, was initially adopted in an effort to stabilise an acute debt and balance of payments crisis that arose at the end of the 70s. Policy was primarily focused on reducing inflation, which at that time stood at 100%, and for the first three years it appeared to be successful. During this time, inflation fell to 30%, and the current account deficit was halved to 2.5% of GDP. By 1987, however, severe macroeconomic imbalances had begun to reappear, and over the next three years inflation rose again, averaging 60%, and the PSBR rose to almost 10% of GDP. [5]

The IMF's response to this deterioration, disastrously as it turned out, was to advise Turkey fully to liberalise its capital account. A part-liberalisation, allowing current account convertibility and enabling specified forex transactions by residents, had already taken place in 1984, but in 1989 all restrictions were lifted on inward and outward transactions by both residents and non-residents alike, and the economy was thus laid bare to the vagaries of the international capital markets. In the event, this worsened the fiscal problem, for as comparably safe dollar assets became freely available, and inflationary instability made domestic currency assets more risky, the government was forced to pay interest rates incorporating a higher spread.

During the 1990s average interest rates on government debt exceeded the average inflation rate of 75% by more than 30 percentage points. As a result there was a rapid build up of public debt, and interest on domestic debt (which had absorbed less than 20% of the tax revenue at the end of the 80s) rose to 75% of tax revenue by the end of the decade. The Public Sector Borrowing Requirement also increased sharply, and bonds and bills issued to meet budget deficits grew from less than 20% to about 40% of GDP over the same period.

Meanwhile the newly liberalised capital markets experienced an exceptionally volatile boom-bust cycle arising from surges and retreats of capital inflows. A boom in the early 1990s, coinciding with a similar boom in Latin America, saw non-resident capital inflows rise to $25bn. This was followed by a bust in 1994, accompanied with a net swing of inflows of roughly $19bn. 1995-1997 saw a period of recovery, but the East Asia crisis again slowed capital flows, and following the Russian crisis and a particularly devastating earthquake, the economy once again fell into deep recession. However, although government debt continued to grow, and the deregulated banking system was becoming increasingly unstable, the CBT was at that time effectively stabilising the exchange rate, and an immediate currency crisis was avoided.

In December 1999 a new stabilisation programme, approved and supported by the Fund, was launched to boost the economy. The main objective was to bring down inflation (then standing at 65.8%) to 22.5% by the end of 2000, and to below 10% by 2002. A form of currency board prevented the printing of money against domestic assets, and the policy was anchored to a crawling peg with a pre-arranged and gradually widening exchange rate path, and a stated exit date designed to smooth the eventual realignment of the exchange rate.

The programme started well. The support of the IFI's encouraged foreign investors, and there was a net positive capital flow of $12.5bn for the first ten months of 2000. This financed both the growing current account deficit and the net outflows by residents, and replenished the reserves; interest rates fell and the budgetary position improved. A strong recovery began, with GDP rising by more than 7%. As the currency appreciated, however, imports surged and the trade deficit doubled, pushing the ratio of current-account deficit to reserves from 10 to 50%. This left short-term debt exceeding reserves by 50% and in effect meant that external payments were dependent on uninterrupted capital inflows. In addition, only a small proportion of these inflows took the form of FDI or portfolio flows, while 90% was debt creating, and a large currency risk borne largely by borrowers was generated, much of it concentrated in commercial banks.

The success of the entire programme therefore relied on the maintenance of positive arbitrage flows, themselves dependent on the confidence of the international financial markets. In November 2000, this confidence collapsed, and in that month alone capital flight by non-residents was estimated to have exceeded $5.2bn. Within a few days the economy was in chaos, with overnight interest rates reaching three digit levels. As the situation snowballed, the CBT first abandoned and then reinstated the currency board in a fruitless attempt to prevent the contraction of the monetary base.

At the beginning of December, the IMF stepped in again, and in exchange for fresh government commitments of extensive liberalisation, provided a financial package of $10.5bn to stabilise the economy. For a short time this action appeared to halt the disastrous outflow of capital, but the respite was short-lived. Among other factors, the policy of predetermining an exit date from the currency peg had relied on inflation falling as predicted. In fact inflation had remained high, causing increasing anxiety regarding the valuation of the currency as the specified date drew nearer. At the end of February 2001, this concern exploded in a devastating flight from the Turkish lira, which could not be checked despite overnight interest rates of 5,000%. The government, supported by the IMF, was accordingly forced to abandon the peg and float the currency, which lost a third of its value against the dollar in a single day.

In May 2001 the IMF again intervened with another stand-by credit of $8bn and a new programme based on projections showing improved stability and growth by the second half of the year, but recovery did not materialise. Instead a vicious circle, comprised of lack of confidence and persisting capital outflows, increased the fiscal problem and pushed up interest rates, making it virtually impossible to stimulate the economy. The events of September 11th further destabilised the situation, and by the end of the year it was clear that the Turkish economy was in the worst recession of its post-war history.

As we have seen above, the IMF has again intervened with another rescue-package predicated on more severe conditionalities, but Turkey's economy remains extremely fragile, its debt burden unsustainable, and its future unclear.

Assessment

No economic crisis can be attributed to a single cause, and the Turkish calamity is no exception. The Turkish economy clearly suffers from particular weaknesses, especially in the fiscal and banking sectors, and its high rate of inflation has been exceptionally difficult to control. Nonetheless it is clear that if the Turkish government had been free to employ some form of capital controls, the acute crises of the preceding two decades would almost certainly have been avoided. Many of Turkey's problems, including its volatile growth-rate, its currency appreciation and its high exchange-rate risk, were the result of capital inflows themselves – inflows that clearly could not be sustained in the long-term. The IMF, however, at no time advised any suspension of convertibility. To the contrary, it encouraged full liberalisation of the capital account, and persisted in providing funds in order to guarantee foreign creditor assets at times of speculative attack. These loans in turn increased Turkey's external indebtedness, as did the need for the government to meet the greatly increased capital outflows by residents that followed capital account liberalisation.

In addition, although it eventually advised the government to float the currency, the Fund had also given its initial support to the currency peg. This allowed no leeway for the government to correct growing current account deficits through monetary policies, and left it reliant on flows of hot money to finance its growing domestic indebtedness. As was the case with the peso in Argentina, it was far too late to restore confidence in the lira by the time the currency was floated again.

Turkey's external debt now stands at $120bn, roughly 80% of her $146.5bn GNP. In 2001, this obligation entailed debt service of $24.6bn, equivalent to 16.8% of GNP. This was roughly four times as much as she spent on health, and four times what she allocated to education (3.9% and 4.1% of GNP respectively). Indeed, since Turkey's total revenue currently amounts to 26.8% of GNP (approximately $39.3bn), servicing her debt takes up 62.6% of her revenue. [6] This is clearly an unsustainable situation, and it is now critically important for Turkey to have her debt burden reassessed in order that she may make a fresh start, and break out of the volatile boom-bust cycle that IMF-led policies have imposed on her economy.

We would therefore recommend a standstill of Turkey's sovereign debt repayments, together with the imposition of temporary capital controls, while her position is examined by a consultative body under a neutral mediator. However, we fear that global political factors, most particularly the aggressive stance of the United States towards Iraq, make it extremely unlikely that any action will be taken in the near future to release Turkey from a debt situation that affords enormous political leverage to her creditors.

APPENDIX 1

Political Parties

There are now 48 political parties in Turkey, three of them launched in the middle of the current crisis, but a threshold of 10% of the vote limits their representation in parliament. The centre right, which historically attracted the greatest support, has recently been weakened by its division into two rival factions the True Path Party (DYP) and the Motherland Party (ANAP). In the elections in 1999, this allowed the ultra-nationalist right, represented by the Nationalist Action Party (MHP) to emerge as the second largest party in the country.

The centre left has traditionally been represented by the Republican People's Party (CHP) and the Democratic Left Party (DSP). Ismail Cem, who resigned as Ecevit's Foreign Minister in July, has since founded a pro-reform New Turkey Party (YTP), and there are numerous smaller parties in the centre-field. Kemal Dervis has now joined the CHP, and hopes to unite some of these under its leadership.

The Islamic parties have also come to form an extremely powerful political faction, despite recent efforts to suppress them (the original Islamist Welfare party was banned in 1998, and its successor the Virtue Party in 2001). Their support is split between two groups; the Happiness Party (Saadet) speaks for the conservative Islamist wing, and the Justice and Development Party (AKP), under its leader Recep Tayyip Erdogan, the popular former mayor of Istanbul, represents the more moderate members. Recent polls have shown that AKP enjoys sufficient support to emerge as the number one party in an election, but Erdogan faces a ban from politics which does not expire until January, and will therefore not be able to lead his party in the early election of November 3rd.

Kurdish political movements have also suffered from political repression, but currently the People's Democracy Party (HADEP) plays an important role, especially in the south east. It is thought that many of its supporters are sympathetic to the now-illegal PKK, and in some areas its representatives continue to endure harassment and obstruction at the hands of the authorities.

The Army has played a crucial role in Turkish politics, and still considers itself the custodian of the secular republic. It has staged three coups since 1960, and was instrumental in removing the welfare-led government in 1997. It wields power mainly through the National Security Council (NSC), which in practice exerts influence on a wide range of issues throughout the country. It must not be overlooked as a force in Turkish politics.

Since 1999, Turkey has been ruled by a coalition government consisting of the centre-left Democratic Left Party (DSP) led by the Prime Minister, the veteran politician Bulent Ecevit, and two rightwing parties, the far-right Nationalist Action Party (MHP) and the centre-right Motherland Party (ANAP).

[1] See Appendix 1, Political Parties.

[2] See the section on Economic Background below

[3] Statistics taken from the IMF's Country Report and Statistical Appendix, July 2002, Nos. 02/137 and 02/138.

[4] This outline of the background to Turkey's economic position relies heavily on information and statistics provided by Yilmaz Akuz and Korkut Boratav (the director of the Division on Globalisation and Development Strategies, UNCTAD, and the Professor of Economics, University of Ankara, respectively) in their paper The Making of the Turkish Financial Crisis.

[5] Akuz and Boratav assert that this failure was due to two factors. Firstly, a return to democracy encouraged popular demand for compensation for the drastic cuts in wages and agricultural subsidies that had been instituted by the former regime. Secondly, domestic financial markets had been liberalised before fiscal discipline had been secured and inflation brought under control, leading to a rise in interest rates, coupled with the shift from central bank financing, that raised the cost of financing public sector deficits. The IMF, on the other hand, simply state that the `limited structural component of fiscal adjustment served to undermine efforts to reduce inflation.'

[6] Statistics taken from the IMF's Country Report and Statistical Appendix , July 2002, Nos. 02/137 and 02/138.

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